Introducing Microfinance to a Commercial Bank

Microfinance is the provision of financial services (loans, savings, insurance and business development training) to very small businesses and people who live in poverty.Microfinance lending began by providing credit to entrepreneurs who want to start or who run very small, low-income and often informal businesses. Many of these entrepreneurs are considered non-bankable by the traditional commercial banking system as they lack credit history and therefore cannot meet the minimum criteria to gain access to credit. Microfinance Institutions (MFIs) address their target clientele’s lack of credit history by using highly specialized processes and tools to evaluate borrowers that focuses on both the customer’s capacity and willingness to pay. These processes enable MFIs to successfully evaluate their potential customers, monitor and measure the associated risks in a consistent manner and a scalable way.

Commercial banks, due to their extensive physical, financial and human resources, can launch and expand microfinance services more efficiently and perhaps less expensively than pure MFI-startups. Retail banks with large branch networks are in a position to allocate fixed costs among many banking products and reach economies of scale in microfinance faster. However, most banks lack experience with the microfinance market and its target clientele and often dismiss this segment as extremely risky and very expensive. Traditional banks also lack the appropriate credit and risk methodologies to approach the microfinance sector successfully. With a very conservative perception, commercial banks may tend to burden microfinance with such policies and procedures that prevent its success.

When the barriers that have traditionally kept commercial banks out of microfinance are overcome, banks can be highly competitive in the microfinance sector mainly because of their branch network.

Banks interested in microfinance may choose among various models: (1) a financial subsidiary (2) an internal unit within the bank (3) the creation of an MFI with bank co-investors, etc.

The decision for choosing among the models is a combination of the macroeconomic environment in the country, existing legal frameworks, cost efficiency considerations, etc. It is important to mention that the operational structure choice is critical to the ability of the microfinance operation to build upon the advantages of the bank.

The right credit methodology and product mix is the most demanding (as well as rewarding) challenges in microfinance. Credit methodology is comprised of a set of activities involved in micro-lending including sales, customer selection and screening, the application and approval process, repayment monitoring, delinquency and portfolio management. It is also linked to the appropriate training of staff.

Microfinance is depended on alternative (non-traditional) ways of distributing credit and other financial services. Some channels (i.e. banking agents) bring the industry closer to the vast majority of low-income people (especially those in hard-to-reach rural areas). The substantial cost reduction is another motivation. MFIs are looking to different channels that may reduce their dependence on the ‘standard branch-and loan-officer model’ and offer a balance between the classic personalized service and an emerging transactional one, like mobile banking.

Technology is an essential tool for microfinance. In particular, information management and communications processes can help the industry to lower operational costs by automating several pieces of the credit process, to reach rural areas faster and to control and lower risks.

Three key lessons emerge from the worldwide experience with commercial banks when downscaling to the microfinance segment:

Understand the market.

Engage management at the highest level.

Develop tailored risk assessment methods.

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Costas Stabolas

Senior Management Consultant

SMART MESSAGE WEEKLY

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